Is it Crazy to Finance if You Can Pay Cash?

Determining whether or not you should finance a home when you can pay cash is a bit complicated. Ultimately, it depends on your personal situation and your attitude toward savings, security, opportunities and calculated risks.

Let’s consider the following…

1. How much do you want this specific house?
The cliché “cash is king” is especially true in a robust real estate market where the inventory is low and many buyers are vying for a limited number of homes. Paying cash can make your offer more attractive when there are multiple offers for the home of your dreams. If other buyers need a loan to close on the house, the seller knows there is a chance that loan may not be approved and, even if it is, it will be at least 25-45 days before he can close on the house. While paying cash isn’t likely to get you a better price, it may very well get you the deal. Of course, in a buyer’s market, the ability to pay cash for a house is less of a factor.

2. If you pay for the house outright, how much will you have left in liquid assets?
If it’s next to nothing, you may want to consider financing at least a portion of the purchase price. That will allow you to keep some funds available to deal with emergencies. Without a “slush fund,” you may be forced to sell your house to deal with large unexpected expenses. On the other hand, if you pay cash, you won’t have a monthly mortgage payment and, with a little discipline, you can direct the money you would have spent on a mortgage into your rainy day account.

3. Are you carrying other debt at a higher interest rate?
If you have a large balance on your credit cards or any other high-interest debt, it almost always makes more sense to pay those off than it does to put that extra money toward the house when interest rates on mortgages are as low as they are.

4. Would you rather have a larger/nicer house or be debt free?
This is a very personal decision and there tends to be two lines of thinking on this question. The first is, “I’ve worked hard to afford certain luxuries that are important to me.” The second is, “The older I get, the less I want.” Using a mortgage will allow you to leverage your nest egg to purchase a more expensive home than you may be able to if you do an all-cash purchase. Of course, that will mean you will have mortgage payments, unless you use a reverse mortgage.

5. Could your money earn you a better return if you invested it elsewhere?
According to Sarah Max, a financial writer with Time.com, “With rates at incredible lows – and mortgage interest deductible – paying cash is the equivalent of locking in an investment that returns roughly 3%-4% a year.” So, if you have an opportunity to earn a return from stocks or bonds or a business venture that is higher than 3-4%, you may choose a mortgage so you can take advantage of that opportunity. Keep in mind the risk to reward ratio. The Great Recession notwithstanding, historically, real estate has been a less risky investment than stocks, bonds or new businesses.

6. Would you actually put the money to work elsewhere?
Just because your money might earn more in another investment doesn’t mean you’ll actually make the investment. If you don’t have a good idea of where and WHEN you will invest the money, there’s a good chance you’ll never get around to doing the research and making the decision on where to put your money. In which case, put your money against your mortgage. At the very least, you’ll likely keep up with inflation.

7. Do you have a great business idea you’d like to pursue?
While many people view retirement as a time to kick back and spend their days socializing, gardening, reading or playing golf, many others see this time as an opportunity to pursue a business idea they’ve been contemplating. If that’s you, you may prefer to use your cash to fund the new business venture. As Mark Twain said, “Twenty years from now, you will be more disappointed by the things that you didn’t do than by the ones you did.” Still, keep in mind business ventures are often risky, so don’t invest money that would devastate you financially if you lost it.

8. What will be the impact on your tax savings?
Most people believe they will have a significant tax savings if they can take advantage of the mortgage interest deduction. I could bore you with the numbers, but trust me when I say it does not make sense to spend a dollar in interest to save 40 cents in taxes, and for most people, the savings are less – much less – than that. There are very few situations where it makes sense to take on a mortgage for the sole purpose of saving on taxes. Ask your tax preparer.

9. Which set of pros and cons makes you more comfortable?

With a mortgage:

Pros:

It allows you keep more cash on hand (although, if you pay for the home outright, you will likely be able to pull cash out with a home equity loan, if needed.)

It keeps cash free for other investments that may have a higher return (although, few investments will have a greater return without subjecting you and your nest egg to higher risks.)

Cons:

Mortgages are more expensive. Both in the short and long-term, you will pay more for your home if you use a mortgage than if you purchased it outright.

If your income is reduced or your other expenses increase drastically, you may no longer be able to afford your mortgage payment forcing you to sell the property or face foreclosure.

If you pay cash:

Pros:

You own it outright. As long as you keep your taxes and HOA fees current, the odds of losing your home are miniscule.

No mortgage payments!

Cons:

If you need to access the equity in your house, it can take several weeks if you qualify for a home equity loan, or several months if you have to sell it.

If you need to sell during a down market, you are on the hook for the entire loss. (It’s worth noting down markets are relatively rare in real estate.)

TIP: Before making a decision, talk about the factors listed above with a top notch accountant and/or tax preparer. If you don’t have a relationship with one, get recommendations from people you trust and make an appointment for a consultation. Yes, it’s going to cost you some money, maybe several hundred dollars, but it will be worth it.

You may be tempted to get advice from your financial planner, your loan officer or even your real estate agent, but keep in mind, your financial planner has incentives to advise you to get a mortgage so you can keep as much of our cash invested with him/her as possible. Your loan officer is going to convince you it makes financial sense to get a loan because that’s how s/he makes a living. Your real estate agent knows if you pay cash, the transaction (and his job) will be easier. The only professionals who don’t have an interest in which way you decide is your accountant and tax preparer. Use them! This decision is too big to not get it right.